Essay: Board oversight responsibilities in joint ventures

 
The board of directors manages the day-to-day functioning of an organization (Mintzberg, 1983).
The board of directors is responsible for monitoring and controlling a firm (Bamford et al., 2004). Boards consist of members that are responsible for addressing the interests of the shareholders (Boubaker et al., 2012). The board is ‘the formal link between shareholders and the managers entrusted with the day-to-day functioning of the organization’ (Forbes and Miliken, 1999).
The board is an ex post governance mechanism (Reuer et al., 2013). Boards have a dual role: to control and to serve (Forbes and Miliken, 1999). Controlling concerns the responsibility to monitor top management and the CEO on behalf of the firm’s shareholders. Boards monitor and oversee operating performance strategic decisions (Westphal and Frederickson, 2001).
Serving consists of advising and counseling. A board of directors could provide expertise and may guide strategy directions (Adams et al., 2008; Forbes and Miliken, 1999). Or as Hillman and Dalziel (2003) term it ‘board capital’. Board capital is human and relational capital that enables a board to fulfill the service role by means of providing tangible and intangible resources. Boards are charged with monitoring and advising the firm and converging interests of shareholders (Westphal and Frederickson, 2001).
Joint ventures
Definition
Joint ventures are a specific form of alliances. Joint ventures are new entities set up and owned by two or more firms (Kogut, 1988). The owners share resources, assets and knowledge within the joint venture (Hibner, 1982). All owners or parents are involved in strategic decision-making (Geringer and Herbert, 1989).
Joint ventures are strategic alliances. Strategic alliances can be described as cooperative arrangements between firms, with the general aim of pursuing mutual strategic objectives (Das and Teng, 2000), and involve partners contributing firm specific, technical or capital assets (Gulati and Singh, 1998).
A joint venture is a separate entity, owned by multiple firms in which they combine resources. A joint venture has two unique features: joint ownership and the pooling of resources of two or more firms (Kogut, 1988).
A joint venture ‘occurs when two or more firms pool a portion of their resources within a common legal entity’ (Kogut, 1988). Reuer et al. (2013) describe a joint venture as an organization owned by two or more independent firms working together under an incomplete contract. Both parents actively participate in the decision-making activities of the jointly owned entity (Geringer and Hebert, 1989). Throughout this thesis, joint ventures will be referred to when a separate legal entity is established, involving equity of both parents.
Joint ventures (JVs) are independent legal entities owned by two or more firms that invest money and assets in it (Hennart, 1988). In classic JVs the owners of the entity have an equal shared ownership (Pisano, 1989).
Equity vs. non-equity
There are two types of joint ventures: equity joint ventures and non-equity joint ventures. Parents that invest equity in new entities are constructing equity joint ventures (Hennart, 1988). Non-equity joint ventures are contractual agreements between two ore more firms (Hennart, 1988). These agreements could include licensing, management contracts, etc.
Alliances can be divided in equity and non-equity alliances. Joint ventures are equity alliances.
International
The joint venture is examined as an international joint venture if at least one of the parents situated outside the joint venture’s country of operation or when the joint venture has a significant level of operations in at least two countries (Groot and Merchant, 2000; Geringer and Hebert, 1989).
In order to form an international joint venture, at least one of the parents should be located outside the venture’s country or the venture’s operations should be in more than one country (Geringer and Hebert, 1989).
This becomes an International Joint Venture (IJV) when the parents have different nationalities (Inkpen & Beamish, 1997). An IJV is unique compared to other forms of strategic alliances because the board of directors has to manage a distinct business entity (Pisano, 1989; Kumar & Seth, 1998; Reuer et al., 2010a). The board of directors’ responsibility is to keep the company running, and are therefore finally responsible for the performance of the firm (Fink, 2005).
Forming joint venture
Joint ventures are formed if an organization seeks access to indigestible assets of a local organization (Sinha, 2008; Chen, 2010). Another reason to form a joint venture is to have access to new markets (Kogut, 1988; Tjemkes et al., 2012). Getting access to indigestible assets or new markets are both costly and time consuming. Forming a joint venture reduces transaction, R&D and production costs (Chen, 2010). At the same time, joint ventures provide access to complementary resources, skills and capabilities (Chen, 2010). A joint venture offers economies of risk, resource and scale (Beamish and Banks, 1987; Datta et al., 2009). Setting up a subsidiary individually or the acquisition of a local firm would be more costly and time consuming (Beamish and Lupton, 2009). Besides, all parents of a joint venture have invested equity in the new entity and therefore incentives are aligned (Kogut, 1988; Oxley, 1997).
Motivations for forming alliances can be: easier market access, reduce innovation time span, or to match complementary technological capabilities (Goerzen, 2007). Engaging in alliances helps firms to improve their resources for future purposes (Ireland et al., 2002).
Need for governance/failure
Despite the advantages of joint ventures, the failure rate is high (Porter, 1987; Kogut, 1988; Park and Russo, 1996). The key reason for the high failure rate is the risk of conflicts between the parent organizations (Tjemkes et al., 2012). If the goals of the parents are not aligned, conflicts may arise (Kale et al., 2000). The lack of alignment between parent’s goals could involve one parent to seek gains at the expense of other parent(s) or the joint venture (Luo, 2007). Pisano (1989) refers to this as opportunistic behavior. Opportunistic behavior could consist of: breaching contracts, withholding information, failing to fulfill obligations, misappropriation of knowledge or withdrawing commitment (Luo, 2007). The majority of joint ventures fail because of opportunistic behavior (Hennart et al., 1998).
Another reason for the high failure rate conflicts with the separation of ownership and control (Kim et al., 2005). Also known as agency issues (Datta et al., 2009). Agency theory is about the relationship between the principal and the agent (Eisenhardt, 1989). The principal delegates the work, the agents executes the work. For joint ventures, the parent firms are the principals and the joint venture management is the agent (Kumar and Seth, 1989). The parents are at risk that local management makes decisions for their own interest instead of the parents interests (Solomon, 2007). Acting out of self-interest is inherent to human nature (Eisenhardt, 1989).
At last, conflicts could arise because of cultural, political, economical or geographical distances. These could result in lose of control of additional costs (Davist et al., 2000).
It is shown that (international) joint ventures are difficult to manage since they face high failure rates. In order to overcome this issue, the parents should align their goals and interest (Kogut, 1988). A parent has to control the venture as well as the co-operating parent(s) (Kamminga and Van der Meer-Kooistra, 2007). International joint venture parents are located in different countries, which make them face the problem of poor control and coordination caused by cultural and physical distance (Groot and Merchant, 2000).
The success of an international joint venture depends on the parent’s joint contributions and efforts. Opportunistic behavior occurs if one parent seeks gains at the expense of the other parent(s). Opportunistic behavior harms joint venture’s performance. Governance mechanisms prevent parents from opportunism (Reuer et al., 2013).
Formal governance mechanisms are required as a consequence of these risks.
Corporate governance in joint ventures
Due to opportunistic behavior, agency problems or distance problems, parents need governance mechanisms to exercise control (Mellewigt et al., 2007). The purpose of governance mechanisms or control mechanisms is to ensure that there is congruence between the parent’s interests and the joint venture’s activities (Schaan, 1983; Kumar and Seth, 1998). Joint ventures have the responsibility to report to multiple parents. Corporate governance mechanisms in joint ventures aim at controlling and coordinating the venture in order to fulfill the owner’s expectations (Geringer and Hebert, 1989).
The hierarchical control features of joint ventures and wholly owned organizations are very similar due to consistent governance attributes (Gulati and Singh, 1998; Gulati, 1995a). The board controls the joint venture’s activities and enhances information flows within the collaboration (Sampson, 2004). Theory on joint venture board of directors is scarce (Klijn et al., 2013).
Joint venture control can be defined as the process by which the parents influence a joint venture entity to behave in a manner that achieves partner objectives (Inkpen and Currall, 2004). Joint venture governance can be distinguished from corporate governance at publicly traded firms by the fact that a joint ventures has two or more forceful owners to report to as opposed to many disperse and anonymous shareholders of which the expectations are not immediately feld (Carver, 2000). The parent firms have great interest in making the new venture succeed and therefore invest strong in governance (Carver, 2000). The amount of control that parents can exert on the JV is a crucial factor in determining the return that a parent can expect from it (Mjoen and Tallman, 1997). Hart (1995) notes that governance is relevant only when two conditions are fulfilled: agency problem and contract incompleteness.
In the absence of an agency problem, the organization members could be simply instructed to act in the interest of the principal, and they would carry out the instructions without having any self-interest about the outcomes of the organization’s activities (Hart, 1995). The agency problem may be addressed by drawing a comprehensive contract, which specifies all eventualities that could occur (Hart, 1995). This way, the agent would be forced to act in the principal’s interest. The reality is that complete contracting is impossible, since people are assumed to have bounded rationality (Williamson, 1981).
Rodrigues (1995:31) recognized the agency problem in the governance of foreign subsidiaries of multinational corporations by stating that the challenge is ‘how to obtain assurance that decisions made by subsidiary managers are in tune with the enterprise’s overall objectives, and that those decisions which must be made by the HQ management are not sabotaged by the subsidiary management.’ Joint venture governance enables the parent firms to exploit their competitive advantage by coordinating the JV’s activities within the parents’ strategy and protects against the loss of competitive advantage to the other parent or other competitors (Kumar & Seth, 1998). Schaan (1983:57) described the purpose of joint venture control as ‘ensuring that the way a joint venture is managed conforms to the parents’ own interest.’ Kim, Prescott & Kim (2005) stress that the difficulty for the principal to observe and interpret the activities of the agent determines the significance of the agency problem. Johnson, Hoskisson & Hitt (1993) argue that the degree of board involvement is based on agency problems that occur when the interests of managers and shareholders are not aligned.
Opportunism in this sense can be defined as an act or behavior performed by one of the parents to seek private gains at the substantial expense of the other parent(s) and/or the joint venture itself (Luo, 2007). According to Luo (2007), opportunistic behavior can involve breaching the contract, withholding information, withdrawing commitment, failing to fulfill obligations, or misappropriation of knowledge.
Empirical findings suggest that when the risk of opportunistic behavior is high, firms are more likely to choose joint ventures as a governance mode (Oxley, 1997). Although the mutual long-term need between partners in a JV may reduce the propensity of opportunistic behavior (Beamish & Banks, 1987), a JV offers opportunities for parents to act in their own interest. Mohr & Sengupta (2002) argue that given a sufficient length of time and degree of closeness in inter-firm relationships, there is the risk of leaking valuable knowledge and hence, jeopardizing a firm’s sources of competitive advantage. In transaction cost economics theory, it is assumed that opportunistic behavior is inherent to human beings (Williamson, 1981).
Opportunism is a fundamental concept in this thesis because the perceived risk of partner opportunism determines to a large extent the need for governance mechanisms. The higher the perceived risk of opportunistic behavior on behalf of the partner, the higher the need to exercise control on the JV. As Luo (2007) states, the risk of opportunism increases monitoring costs (Luo, 2007). The gains in terms of knowledge contributed by the local partner must outweigh the costs associated with preventing knowledge leakage to and opportunistic behavior of the partner (Beamish & Banks, 1987). Partner opportunism makes incomplete contracting hazardous and determines the need for subsequent governance mechanisms (Luo, 2007). Luo (2007) argues that a parent firm’s degree of opportunism is not pre-fixed but contingent to endogenous factors. Hence, the risk of opportunistic behavior can be seen as a mediating factor between these factors and the need for control.
Board of directors in joint ventures
Boards of directors of joint ventures represent the parent firms (Kumar and Seth, 1998; Pisano, 1989). The board is considered to be a formal governance mechanism (Hewitt, 2005). The responsibilities of the board are monitoring and coordinating the venture on behalf on the parents.
Joint venture boards are very similar to boards of unitary organizations. The joint venture board is responsible for controlling the venture, providing advice, safeguard the parent for incomplete contracts and addressing shareholder’s interests (Reuer et al., 2013). However, joint venture boards are also responsible for achieving unity between the parents (Petrovic et al., 2006). Joint ventures have two or more parents with different interest, which the board has to coordinate. Ravassi and Zattoni (2006) identified this political role in which the board has to align/coordinate interests. Joint venture boards have to align/coordinate parent’s interests next to shareholder’s interests (Petrovic et al., 2006; Reuer et al., 2011). The joint venture board is a valuable governance mechanism by maintain and improving the relationships between parents and resolving their conflicts (Petrovic et al., 2006). It is likely that there will be cultural differences among the delegates of the parents in international joint ventures (Bjorkman, 1995). Another unique feature of joint venture boards that they serve as communication channel between the joint venture and the parent firms (Groot and Merchant, 2000). For instance, updating the parents about the joint ventures performance or updating one parent about a co-parent.
Reuer, Zollo & Singh (2002) acknowledge that joint ventures involve contingencies that the parents cannot anticipate at the time of formation. Child (1998) emphasizes that, in order to deal with contingencies that are difficult to anticipate and to monitor the development of the joint venture, the board of directors plays a crucial role. Similarly, Reuer, Klijn & Lioukas (2013) consider the board of directors as an ex post governance mechanism that enables the parents to fill the gaps in contracts.
A key assumption in the governance literature is that the election of the board of directors gives the principals, in this case the parent firms, the capacity to make sure that the agents handle in their interest (Child & Rodrigues, 2003).) The board of directors provides a direct communication link between the parent firms and JV management (Oxley & Michigan, 1997).
A widely used description of the board of directors first provided by Mintzberg (1983) is ‘the formal link between the shareholders of a firm and the managers entrusted with the day to day functioning of the organization’ (e.g. Forbes & Milliken, 1999). Maassen (2007) describe that the primary control responsibility of the board is to assure that the executive managers are acting in the best interest of the shareholders. Carver (2000) states that ‘[the] only direct, legal connection [of the parent firms] to the new company is their representation in the board of directors’ (Carver, 2000:76). Leksell & Lindgren (1982) emphasize that board members serve as a communication and information-processing channel between the parents. The JV board is responsible for monitoring and overseeing the JV to meet the parents’ objectives (Kumar & Seth, 1998).
Boards of joint ventures seem to be more active than boards of wholly owned subsidiaries (Leksell & Lindgren, 1982). This can be related to the fact that a JV typically has two direct owners which have a great interest in making the venture succeed, rather than a disperse set of shareholders (Carver, 2000). Since parents’ motives can diverge greatly, the board is an important governance body through which the parties can exert their interests (Petrovic & Kakabadse, 2006; Reuer et al., 2011). Kamminga & Van der Meer-Kooistra (2007) assigns high importance to meetings and personal contacts in joint venture governance, due to the difficulty of transferring tacit knowledge, which a board of directors can facilitate. Research of Garcio-Canal, Vald??s-Llaneza & Arino (2003) indicates that joint venture boards tend to meet on average 5.1 times a year, which can be considered frequently and suggests that boards of directors are generally involved in joint ventures (Reuer, Klijn & Lioukas, 2013).
The board of directors of a joint venture serves as the main forum for partners to coordinate the activities of the entity and discuss the future strategy as well as providing information and advice on how to operate in the local environment (Carver, 2000; Leksell & Lindgren, 1982). Leksell & Lindgren (1982) add that the board becomes the primary body in which conflicts between the owners are discussed and resolved. According to Klijn et al. (2013), the board of directors has a twofold impact regarding the control of partner opportunism. On the one hand, the perceived JV board involvement can help to prevent opportunism in the first place. On the other hand, in the case that opportunistic behavior occurs, the extent to which a board of directors is involved in the JV, determines in which stage this behavior is identified. The earlier opportunism is detected, the more can the board contribute to reducing the losses incurred (Klijn et al., 2013). By means of board involvement, JV parents have the opportunity to their rights and adjust operations in response to opportunism (Balakrishnan & Koza, 1993; Klijn et al., 2013).
The three main roles of the board as identified by Leksell & Lindgren (1982) are an external role, involving external relations and advisory; an internal role, including control and monitoring, coordination and strategy formulation; and a legal role. Furthermore, a distinction is often made between a monitoring and an advice function (e.g. Klijn & Reuer, 2011; Reuer et al., 2010a).
Regarding the board of directors in joint ventures, Carver (2000:77) states that ‘every other aspect of enterprise has received more study, more model-building and has undergone more painful self- examination than has the most powerful function of all.’ Judge & Zeithaml (1992:768) identified a gap in literature on board in general: ‘researchers simply do not know what boards’ roles are in the strategic decision-making process, nor do we know what influences that involvement.’ The fact that this topic has received relatively little attention makes the board of directors an interesting subject of study.’In this thesis, the term ‘board involvement’ will be used to describe ‘the extent to which the board is engaged in controlling and coordinating an international joint venture’s activities on behalf of the parent firms’ (Reuer, Klijn & Lioukas, 2013:9). A board of directors may entail many functions (e.g. Carver, 2000; Leksell & Lindgren, 1982), and the monitoring and advice functions are often intertwined (Reuer et al. (2010a). In this thesis the focus will be on the role of the board of directors as governance mechanisms used for internal control of the JV. The internal role of the JV board involves monitoring and evaluating the JV’s executive managers, and approving and coordinating the JV’s strategic plans and actions with the objectives of the parents (Kumar & Seth, 1998).
‘(…) the board of directors’ function is to manage the business and affairs of the corporation’ (Klein, 1998: 277). Boards have to align the interests of managers and shareholders (Oviatt, 1988; Agrawal & Knoeber, 2001). More specifically, the responsibilities of board of directors are often categorized in monitoring and advice (e.g. Gulati & Westphal, 1999; Klijn & Reuer, 2011; Westphal, 1999; Reuer et al., 2010a; Kriger, 1988; Coles et al., 2008).
Many scholars argue that monitoring, or control (Hillman & Dalziel, 2003), is often described as the most important role of the board of directors
(e.g. Fama, 1980; Hillman & Dalziel, 2003; Weisbach, 1988). Fama (1980) describes the board of directors as the ultimate internal monitor of the firm. Monitoring is examining the highest decision makers in the firm (Fama, 1980), or in other words, evaluating management (Weisbach, 1988). Boards monitor the managers to protect the interests of the shareholders (Hillman & Dalziel, 2003; Forbes & Milliken, 1999), while not being involved in day-to-day activities (Forbes & Milliken, 1999). The specific activities that directors undertake when they monitor a firm are monitoring the CEO and senior managers, monitoring strategy implementation, and monitoring the organization’s operating performance (Hillman & Dalziel, 2003; Klijn & Reuer, 2011). In the context of IJV, Reuer et al. (2010a) found that boards in IJVs have more extensive oversight responsibilities when they are broad in scope and that the extent of monitoring diminishes when environmental uncertainty is present.
The advisory role of the board is less extensively discussed than the monitoring role (Williamson, 1984; Coles et al., 2008). While a firm’s need for monitoring declines in uncertain environments (Gillan, Hartzell & Starks, 2003; Boone et al., 2005), the need for advice increases (Coles et al., 2008). Directors can offer advice by giving the firm access to valuable information (Westphal, 1999), and offering counsel to top management (Reuer et al., 2010a). Reuer et al. (2010a ) state that the monitoring and advice roles are entangled because specific advice can results in monitoring and vice versa. In contrast to other scholars and especially agency theorists, Mace (1971) argues that boards mainly fulfill an advisory role. He argues that top management makes the decisions because they are involved in the day-to-day activities. Management can turn to the board for council because most directors are also involved in other companies and can therefore give useful advice. He further argues that boards only monitor in crisis situations, for instance, when the CEO dies or performs extremely unsatisfactorily.
Monitoring role
The board is responsible for controlling the joint venture’s overall performance. Overall performance is primarily measured on financial performance (Adams et al., 2008). Besides boards frequently check delivery times, production defects, complaints or other operating statistics (Groot and Merchant, 2000).
Coordination role
The board could also be involved in strategy formulation and development. By doing so, the board coordinates the future direction of the venture to ensure that operational behaviors match with the outlined strategy (Stiles, 2001). Involvement in strategy formulation and development is a board continuum (McNulty and Pettigrew, 1999). It ranges from simply approving or rejecting proposals to establishing opportunities for strategy dialogue and promotion (McNulty and Pettigrew, 1999).